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The Payday Shark in Your Bank Account

by Alex Mikulich Ph.D.

A stunningly attractive new product is being offered by at least four banks nationwide. The product—to use an overly respectful term—is called a Direct Deposit Advance (DDA). The problem: DDAs work just like a predatory payday loan and appear to be even more deceptive.

People who have their paycheck or social security benefits check deposited directly into their checking account with either Wells Fargo, US Bank, Fifth Third, or Regions are vulnerable to this deceptively simple form of a payday loan. Regions, based in Birmingham, Alabama is pushing its “Ready Advance” in Gulf South states.

DDAs are attractive because banks make them easy to get at a branch, an ATM, or over the phone, 24 hours a day, seven days a week. “Ready Advance” is just a click away inside of an online account at Regions. Many borrowers assume they have gotten a low-cost cash advance rather than a loan. Borrowers may think that the 10% fee on $100 is cheaper than other credit (like 18% on a credit card) but $10 for a $100 loan repaid in ten days, which is a typical bank DDA (payday) loan term, is 365% APR.

In a typical bank payday loan the bank pays itself back as soon as the next paycheck or benefit check is deposited on the account. The Center for Responsible Lending found that there was an average of ten days between a borrower taking out a loan and the borrower getting their next pay or benefit check. So the consumer may not “fall behind” on the DDA because the bank has paid itself from the borrower’s account; rather, they are current on the DDA but short on money to pay for other regular bills. If a borrower takes out more loans to pay existing bills, it only compounds their debt burden.

Even worse, the borrower may see the problem as high overdraft or bank fees, not linking overdrafts on their account to the DDA. The bank does not actively “collect” the loan or warn borrowers of the approaching loan due date so borrowers frequently do not recognize the source of the overdrafts and the reason for their indebtedness. If 35 days pass without any deposits into a borrower’s account and the bank cannot pay itself, the bank may close the account.

A DDA disclosure by Wells Fargo warns of these consequences: “If there are insufficient funds in your Linked Consumer Checking Account at the time of Automatic Repayment, your account will become overdrawn when the outstanding advance is repaid and any other transactions posting on that day would be subject to overdraft or insufficient funds fees. If you cannot repay your overdrawn balance and fees, you risk closure of your Linked Consumer Checking Account and negative information may be reported to consumer reporting agencies. This may impact your future ability to open a deposit account or qualify for credit.” (Wells Fargo Bank statement quoted in Center for Responsible Lending, “Predatory Payday Lending by Banks on the Rise”.)

Indeed, a Harvard Business School (HBS) study found that banks closed over 30 million debit/checking consumer accounts involuntarily between 2001 and 2005 for excessive overdrafts, with these former bank customers having limited or no subsequent access to the formal banking system. Utilizing county level data, the HBS study found that involuntary closures “are more frequent in counties with a larger fraction of single mothers, lower education levels, lower wealth, and higher rates of unemployment.” The HBS faculty also found that payday lending increases the odds that households will overdraft and ultimately lose their accounts. The study, “Bouncing Out of the Banking System: An Empirical Analysis of Involuntary Bank Account Closures,” is co-authored by Dennis Campbell, F. Asis Martinez Jerez, and Peter Tufano.

The Center for Responsible Lending (CRL) finds that bank payday borrowers are in debt for 175 days per year, which is twice as long as the maximum length of time the Federal Deposit Insurance Corporation advises is appropriate. DDA terms permit indebtedness for eleven months per year. Nearly 25% of bank payday borrowers are social security recipients. A DDA loan can be up to 50% of a paycheck or deposited benefits. See “Big Bank Payday Loans: High Interest Loans keep customers in long-term debt”.

The payday sharks are no longer only at the street-corner store—they may be inside your bank account.